COGS - Cost of what now?
Cost of Goods Sold – What is it, and do I have it?
Wanna get in the middle of a (sometimes heated) discussion between bookkeepers and tax preparers? Almost every Profit and Loss statement I see for a business has some expenses reported as “Cost of Goods Sold”, or COGS. Most people think of this as the direct costs associated with producing your business products or services. COGS are tax deductible expenses - and if you are tracking certain items against specific jobs it can really help to see if you are profitable or not. For Example:
Paul is a handyman and just built a small back porch for a client. His client paid him $10,000 to build the porch and the bid included time and materials. The materials cost him $6,000. He is reporting the building materials as COGS on his P&L and he can see that his gross profit for this particular job is $4000
Sarah does photography as a side hustle. She purchases a lot of props to use with her clients and likes to record them as COGS for the specific job she initially buys them for.
Jennifer has an ETSY store where she sells custom t-shirts. She keeps quite a few styles and sizes of shirts in stock as well as some preprinted seasonal designs. She is careful about tracking her inventory, and reports the cost of the shirts, and shipping materials as COGS.
Let’s talk about what COGS does and does not include.
What is included: Components: COGS includes all direct costs associated with a product, such as the raw materials and the wages of the workers who assemble it.
What is NOT included: COGS does not include indirect costs like marketing, sales staff salaries, or general administrative expenses
According to the IRS Cost of Goods Sold is a very simple equation
COGS = Beginning Inventory + Purchases - Ending Inventory
(If you really want to nerd out, go to https://www.irs.gov/pub/irs-pdf/f1125a.pdf for form 1125-A for the worksheet and instructions on how to calculate COGS.)
This gets sticky when we talk about service businesses in particular. If you are a sole proprietor, and you sell your time/service…what was the cost of producing your time/service? If you don’t have inventory, can you have COGS?
“Does it even make sense?” argues the tax preparer. “But,” the bookkeeper yells, “the math still works on the equation!”
Does it even matter?
If you’ve ever been frustrated by your tax professional telling you “It depends” as the answer to every question you’ve ever asked, I’m here to tell you once again….
It Depends.
As a tax professional, I’d tell you if you aren’t keeping inventory you don’t have COGS, and all of those purchases should be summarized in the Expenses section of your profit and loss. I’d recommend to Paul that the materials he bought for the porch job are just “supplies and materials” and get added to all the other supplies and materials he buys throughout the year.
But if I’m the bookkeeper and Paul really wants to track his direct job costs above the line as COGS, because it helps him make more informed decisions for the upcoming jobs he is bidding, then I say go for it! The P&L is a tool to understand your business and should reflect your individual needs.
At My Team Tax, we are going to ask what your P&L means to you and make sure that the numbers are all flowing onto your tax return correctly. Once we’ve had the conversations to understand your business and how your financials are tracked, then maybe we move your COGS and include it with Supplies on the tax return (still fully deductible – don’t worry!) and maybe we don’t.
But you’ll know what happened, and why we did it that way.
